Financial Regulators Embrace Artificial Intelligence

Amazon.com, Google, and Chinese Internet searcher Baidu are
among the companies with massive computing capacity that you
might expect to be deploying small armies of computer
scientists intent on developing potential uses for artificial
intelligence. But now some perhaps less obvious players are
getting into the machine learning game: financial
regulators.

In an October speech, for example, Scott Bauguess, deputy
director (and current acting director) of the Securities and
Exchange Commissions economic and risk analysis division,
said the regulator was leveraging topic modeling and sentiment
analysis to map these topic and tonality signals into
known measures of risk  such as examination results or
past enforcement actions  using machine learning
algorithms.

Bauguess, who has a bachelors and a masters
degree in electrical engineering from the University of
Illinois and Arizona State University, respectively, can speak
with authority about such techniques, which are allowing
analyses of previously impenetrable information sets  for
example, those without structure, such as free-form text.
Dealing as it does with free-narrative documentation from the
firms it regulates, the SEC is taking a machine learning
approach to behavioral predictions, particularly in the area of
market risk assessment, which includes the identification of
potential fraud and misconduct, Bauguess said.

The SEC and Bauguess stand out as, dare I say, regulatory
technology innovators. And they are not alone. While regtech
has recently attained buzzword status, it has manifested mainly
in the context of systems and services that help with
firms regulatory compliance and reporting. For example,
NEX Group, the London-based automated trading and data services
company formerly known as ICAP, seized on the trend last fall
when it acquired Abide Financial, a specialist in regulatory
reporting technology. And in January capital markets software
provider Risk Focus moved its Report-it compliance product into
a new unit,
RegTek Solutions.

Regulators, meanwhile, are blazing a regtech trail of their
own, turning on its head the long-held assumption that
supervisory agencies cannot keep pace with the deep-pocketed
firms they oversee. Several  notably, the U.K.s
Financial Conduct Authority, the Monetary Authority of
Singapore, and the U.S. Office of the Comptroller of the
Currency  have signaled support, and in some cases
outright encouragement, of entrepreneurship in fintech.

Although a February report by the International
Organization of Securities Commissions suggests that
fintech adds a layer of complexity to such conventional
supervisory responsibilities as investor protection and
financial stability, the multinational regulatory group affirms
that fintech and regtech can improve compliance oversight with
data analysis tools and software. Regulators also may
explore leveraging new compliance software and surveillance
tools, the group said in the report.

The SEC began to do exactly that in reaction to the
200809 financial crisis and the 2010 flash crash
 systemic breakdowns that regulators didnt see
coming. Hedge fund industry veteran Gregg Berman joined the
SECs division of trading and markets and spearheaded
development of the Market Information Data Analytics System
(MIDAS), which seeks to improve transparency to analyze trends
and prevent crashes. The more ambitious Consolidated Audit
Trail (CAT), an idea first floated in 2010 to give the SEC a
complete database of market activity, is finally getting off
the ground following the awarding of a contract in January to
Thesys Technologies, the same trading technology company
that worked with Berman on MIDAS. (Berman left the SEC in 2015
and is currently director of research  market integrity,
monitoring, and surveillance at Citadel Securities.)

CAT will be the largest data repository of securities
trading activities that has ever existed, predicts SEC
commissioner Kara Stein, who has been advocating, thus far to
no avail, the creation of an Office of Data Strategy to
coordinate data and analytic initiatives dispersed throughout
the agency.

The SEC took another leap toward parity with the private
sector in 2015 with Kx Systems kdb+, a high-performance
database more typically used in trading and risk management by
the biggest Wall Street banks.